Written Words

Reducing risk and uncertainty in water quality trading

We need to
use every possible approach to improve water quality across the US. The great
news is that many facilities are investing in onsite upgrades to comply with
nutrient limits. But in places where achieving necessary reductions become very
expensive, water quality trading
(WQT) can help get there cost-effectively. It’s a relatively new environmental
market, with less of a track record than wetland mitigation banking,
conservation banking and carbon credits.

WQT
works by establishing a scientifically-determined “cap” on the amounts of
fertilizer or other pollutants that a lake, bay, or stream can handle, and then
letting water utilities and other pollution emitters “trade” their allowances
to find the most efficient ways of meeting the cap.

Trading
programs had been adopted in eleven states in 2014
(thirteen, if you count Kentucky and Indiana for their participation in the
Ohio River Basin Interstate WQT Project), growing to 21 states
with programs—or permitting trading—in 2016. Despite this growth
in new program popularity, the actual volume of trades is relatively low. Water
quality trading’s limited application begs the question, why is
it not more widespread?

Over the past couple of years, a few analyses have dug into this question of why water quality trading has not taken off as much as some other environmental markets. An October 2017 report by the US Government Accountability Office points out that a key factor in generating water quality trading demand is the existence of discharge limits. That is, a cap on the quantity of nutrients such as phosphorus and nitrogen that a source or facility can legally emit.

The GAO
report further highlights that nonpoint nutrient credit generators (typically, agricultural
operations) have a hard time quantifying their nutrient reduction amounts with
certainty. They can use models to measure credit generation, but regulators
require additional measures to account for uncertainty in the models. Those
additional measures can be cost-prohibitive, which leads to a lack of
participation. Credit measurement shortcomings translate to market uncertainty for
buyers, too. Buyers fear that credits might be invalidated by regulators
because they do not meet standards for nutrient reduction.[1]Buyers don’t want to jump into a
market when they don’t have confidence in what they’re buying.

This seems
like a case of letting the perfect be the enemy of the good. Models and
estimates of nutrient benefits might be sufficiently accurate to build
effective programs for the long-term. We just need to build a culture of trust
around the use of models and technology. Otherwise, nonpoint nutrient credit
trading won’t get off the ground.

EPA’s
February 2019 memo, which strengthens federal support for water
quality trading and encourages states and tribes to implement trading programs,
suggests stakeholders “consider allowing credits to be generated and verified
based on scientifically defensible estimates of pollutant reductions from applicable
technologies and land-based practices.” This means that utilities and farms
could rely on models to predict nutrient runoff reductions. So long as
regulators can agree with these modelling standards, the threat of buyers being
out of compliance should fall by the wayside. Further, programs should allow
for adaptive management to iterate and improve credit development standards
while assuring market predictability.

Even more recommendations come from an October 2018 report, spearheaded by Willamette Partnership and Forest Trends’ Ecosystem Marketplace, that offers an extensive list of approaches for accelerating the uptake of water quality trading in the US, for audiences including municipalities, utilities, nonprofits, and the EPA. These ‘priority actions’ are based upon a series of interviews and research into barriers that have hampered trading. They include things like (1) simplifying trading programs, (2) addressing staffing and funding shortages at state regulatory agencies, and (3) addressing risks that scare off potential credit buyers.

To dig into
WQT at a local level, I spoke with people involved in managing WQT for Idaho
and the Lower Boise Watershed. Idaho has its own WQT
guidance, which means trades can happen any time. Trading in the
state isn’t widespread, but there is a history of trading
among trout farms. What might prove invaluable in the future is that
the trading infrastructure and guidance is already established; it will be there
when it’s needed. Once facilities complete upgrades to meet their TMDLs, they
will likely have some final reductions that can be cost-effectively achieved
via trading. For instance, some small municipalities recognize that even after
their upgrades are completed, meeting their TMDLs could come with high chemical
treatment costs. If they can avoid those through trading, they will save money
while still complying with overall reduction requirements.

Idaho also
uses a unique approach to watershed management: a statewide network of Watershed
Advisory Groups (WAGs) that design WQT frameworks on a watershed
basis. The Lower Boise group in particular meets regularly, hears presentations
from visiting experts, and works through key barriers to trading.

With a
little work, WQT could happen on a large scale in the next few years. It’s a great tool for achieving nutrient
reductions and improving water quality. In order to make it work for more
participants, regulators such as EPA and especially states must do more in
order to address market uncertainty by establishing more protocols to model
offset values and policies that create regulatory certainty for credits; WQT
guidance should also develop ways in which to transfer risk to the credit
developer, rather than the buyer; and, programs like the NSF Seed Fund
should invest in technology and innovation to more accurately calculate offset
value over time so programs can improve.

[1]One
analysis
offers a very compelling example: “in the early days of California’s carbon
market, participants were uncertain about what would be considered a violation
and what it would take for the Air Resources Board to invalidate offsets.
Project developers worried that regulators would retroactively invalidate some
credits, forcing the credit owners to replace them at their own cost. When a
2014 investigation resulted in Air Resources Board invalidating a large number
of offsets, those fears were confirmed and trading of offsets in the California
market dropped substantially as a result (Goldstein, 2015).”